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In the eye of the storm

Sheila Bair heads the FDIC. Sheila Bair heads the FDIC.
By Steven Syre
Globe Columnist / September 26, 2008
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Funny, Sheila Bair never made any list of the world's most powerful women while she was teaching financial regulation at the University of Massachusetts in Amherst.

Now Bair, plucked from the campus to run the Federal Deposit Insurance Corp. in 2006, is in the eye of the financial storm enveloping hundreds of banks. The regulator Forbes currently rates as the world's second most powerful woman is a Republican appointee with some ideas that sound a lot like those coming from Democrats Barney Frank and Chris Dodd.

Congress and the rest of Washington are watching the FDIC's sweeping new effort to systematically halt mortgage foreclosures and rework troubled home loans owned by the failed IndyMac Bank. It's way too early to have any idea how it's going to work.

Lots of people are also watching for the coming tide of bank failures that is almost certain to swamp the FDIC and force the insurer to borrow government money to cover deposit guarantees. Even Bair concedes the FDIC might need to borrow money from the Treasury Department to cover short-term cash-flow pressure. Premium increases expected to be proposed by Bair won't solve the immediate problem.

The FDIC reported $45 billion in capital, representing about 1 percent of all deposits insured, on June 30. The July failure of IndyMac, which could cost the FDIC $8.9 billion, by its own estimate, punches one hole in that reserve.

But there are more than 100 other institutions on the FDIC's list of problem banks. Some analysts believe the insurer will have to cover $200 billion in deposits at failing institutions by the end of the year.

Last night, the government intervened, seizing Washington Mutual, the nation's largest savings and loan, which alone reported deposits of $182 billion as of June 30.

Covering insured deposits is only half of the FDIC's job when banks go bad. Disposing of the bank assets it gets in return is complicated, time-consuming, and potentially expensive. Bair may end up with assets worth hundreds of billions of dollars before long.

Failed banks own all kinds of assets, but they own many billions of dollars of troubled home mortgages that will fall into the hands of the FDIC. Bair has been blunt with Congress about the importance of helping homeowners avoid foreclosure.

"While some level of home price decline is necessary to restore US housing markets to equilibrium, unnecessary foreclosures perpetuate the cycle of financial distress and risk aversion," Bair told the House Financial Services committee last week.

This is a familiar point of view for the regulator, who did not arrive in Washington from Amherst as a political newcomer. Bair was working in Washington as assistant secretary of the Treasury for financial institutions until 2002. She already didn't like what she was seeing in the mortgage market then.

"In 2002, she had tried to get the Federal Reserve to pay attention to subprime loans," says Tom O'Brien, former dean of the Isenberg School of Management at UMass. "She was worried there was fraud being perpetrated, and she was sure this was going to cause tremendous problems for people taking out the loans. But none of us saw the systemic risk and how it mushroomed. But we used to talk about the fact that she couldn't get the Federal Reserve to take that seriously."

Ben Branch, a UMass finance professor and friend of Bair's, recalls similar conversations in Amherst.

"She was way ahead of the curve on all these problems and trying to get people's attention. Unfortunately, people didn't listen to her so much."

Since becoming FDIC chairman, Bair has complained lenders were not doing enough to help borrowers with troubled loans avoid foreclosure. Last October, she pushed lenders to freeze introductory interest rates on some high-cost loans to protect borrowers.

Now, Bair has her work cut out for her with the mortgage portfolio at IndyMac. About 40,000 of the 60,000 delinquent mortgages IndyMac owned or serviced are eligible for her streamlined "loan modification plan." The idea: Limit losses by rewriting loans to "affordable and sustainable" terms.

"Future defaults will be reduced, the value of mortgages will improve, and servicing costs will be cut," Bair said in congressional testimony. But no one knows how that will really work out on such a grand scale.

As the mortgage crisis eventually unwinds, a lot of its bad paper will end up on Sheila Bair's desk. That sounds like a job for one of the world's most powerful women.

Steven Syre is a Globe columnist. He can be reached at syre@globe.com.

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